As an investor, would you rather invest in a country with a
floating exchange rate or a tight peg to a hard currency, or
where a tender is secured to a hard currency with a looser peg,
and which is 'managed’ by the local central bank
using a wide range of flexible financial tools? The issue
matters deeply: it may be the most important decision facing
corporates and investors when deciding whether or not to put
capital to work in the region.

Many central banks across Sub-Saharan Africa choose the
latter route, allowing their currency to fluctuate within a
tight trading band against a hard currency, usually the US
dollar or, in western Africa, the euro. Others bind their
currency to a stronger regional peer: the Namibian dollar, for
instance, is pegged at par to the South African rand.

To many authorities, the managed route is the most sensible
option. "Most countries in Africa don’t have a
flexible exchange-rate regime, as their economies are
structured to withstand shocks, so they run a managed peg where
currencies can fluctuate within a tight band, allowing the
central bank to interject sporadically to manage the peg," says
Gaimin Nonyane, senior macro-economist at pan-African lender
Ecobank. "This allows companies to manage shocks, and to avoid
big swings in the FX market, which would lead to foreign
investors incurring major losses. Managed pegs help to reduce
that exposure."

A few sovereigns opt for a floating-rate mechanism
– Ghana, where Access Bank has a thriving domestic
business, springs to mind, as does South Africa. These are
historically strong and diversified economies (accepting that
global gyrations have in recent times affected both countries)
with open capital accounts. In theory, corporates and investors
can put their money to work in either market whenever and
however they like, safe in the knowledge that they can
re-appropriate that capital any time.

Each approach has its proponents and critics. Floating rate
mechanisms are attractive to foreign investors but could leave
the host nation struggling if a currency tumbles in value
against the likes of the US dollar, as has been the case
through much of 2015. If a government then reacts by imposing
sudden capital account restrictions, it would dent its image in
the eyes of foreign investors. This outcome in one or more
economies, given the global threat to local currency stability,
is far from improbable.

Under pressure

Central banks need
some wiggle room within which to work

Roosevelt Ogbonna,
Access Bank

In a July 2015 report, Renaissance Capital warned that
several regional currencies were under "significant pressure",
due to dollar strength and localized macroeconomic imbalances,
notably the Kenyan shilling and the Nigerian naira. Conversely,
it noted that the Ghanaian cedi and the Tanzanian shilling were
undervalued. "In East Africa, we have seen most currencies
depreciating at a faster pace in recent years," says Jean
Claude Karayenzi, managing director at Access Bank in the
central African state of Rwanda. "Foreign currency inflows into
the region have been affected negatively by the low prices of
mineral and other essential commodities. On the other hand, we
have seen a high demand for imported products, thus putting
pressure on most local currencies and on our trade
deficit."

Managed currencies have their own detractors. They typically
exist in immature or underdeveloped markets, and can get
expensive if a local currency slips sharply in value against
the tender to which it is pegged. The fixed or floating debate
will rage for years if not decades to come. What makes the
argument relevant right now for Sub-Saharan Africa countries is
that bilateral US dollar exchange rates have become the nominal
anchor for expectations about inflation and a host of economic
variables. "This creates a special role for central banks in
terms of managing the value of their currencies against the
dollar, regardless of where they may be trending in real
effective terms," says Alan Cameron, chief Africa economist at
London-based boutique investment bank Exotix. "With the
deepening of markets over the last decade or so, the debate is
not just about trade flows: in many of these countries,
cross-border capital flows have become equal if not larger than
the trade flows, and therefore are just as important in the
determination of 'fair value’ exchange rates."

The pressure on currencies across the region forces
corporates and investors to give serious thought to whom they
want to manage their foreign exchange needs. Local lenders
might offer specific, small-scale solutions, but
it’s the big regional lenders, such as Access
Bank, that offer a range of services that fit each market, and
can aid an institution seeking regional solutions to its
regional currency needs and demands.

Regulation route

The problem is most acute in major economies heavily
dependent on oil revenues. (Nigeria for instance sources 98% of
its export earnings from the sale of oil and gas.) "Over the
past year, a lot of African currencies have come under
pressure, especially oil dependent countries due to the
continuing decline in oil prices," says Adedapo Olagunju, group
treasurer at Access Bank. "Consequently, these
countries’ central banks have resorted to
regulation to protect their respective currencies. To this end,
regulation more than market forces has been the major
determinant of the value of these currencies."

A case in point is Nigeria’s central bank. Its
governor, Godwin Emefiele, has rejected calls to devalue the
naira, as fears rise about the economic and fiscal challenges
facing Africa’s largest economy.
Emefiele’s plan, which involves restricting
imports of food, cement and other goods in an attempt to boost
local production, aims to raise the value of the naira and
boost the country’s dwindling foreign reserves,
which have fallen more than 20% since mid-2014, and are set to
decline further. Nigeria’s FX reserves slipped to
$31.3 billion at end-August 2015, according to data from the
Central Bank of Nigeria, offering the country only five months
of import cover.

Add Your Comment

All fields are compulsory

All comments are subject to editorial review as we are subject to the same regulations adhered to in publishing our own content. For this reason, your comment may not be live immediately, or may not be published.

Magazine

The material on this site is for financial institutions, professional investors and their professional advisers. It is for information only. Please read our Terms & Conditions, Privacy Policy and Cookies Policy before using this site.